In managing an investment portfolio, a key decision is how to allocate the portfolio assets among different asset classes such as stocks, bonds and cash. This decision may have a large effect upon investment performance. Asset allocation is particularly important with respect to investing for retirement. Typically, retirement investment strategies face a number of uncertainties: (a) Fluctuations in the investor's income over time, (b) market volatility (market risk), (c) failure to save enough for retirement (savings shortfall risk), (d) the possibility of outliving one's assets (longevity risk), and (e) potential loss of purchasing power (inflation risk).
A conventional response to the problem of setting a retirement investment strategy has been the so-called “glide path”, which is a year-by-year process of adjusting a portfolio's asset allocation according to the investor's age. The typical glide path shifts the portfolio toward conservative, fixed-income assets and away from riskier, equity-like assets as the investor grows older. There are numerous investment funds—known as “target funds”—that will perform this reallocation more or less automatically.
Conventional strategies for retirement investment usually rely on risk models that characterize factors such as inflation rates, economic-growth rates and asset price volatility as having a “normal” or “Gaussian” distribution. Thus the conventional approach to the glide path assumes that market performance will not differ by a large amount or for long from historical averages. However, there are reasons to question this assumption, since actual historical market performance has been characterized by anomalous events, such as the Sep. 11, 2001 attacks and the 1987 market crash. Accordingly, the conventional glide path retirement investment strategy may fail to reflect real world risks.